Disney magic hasn’t exactly worked on Pixar

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By Jeffrey Goldfarb and Grace DaiThe authors are Reuters Breakingviews columnists. The opinions expressed are their own.

Walt Disney boss Bob Iger has another Pixar hit on his hands. “Monsters University” should provide an eighth consecutive animated lift to Disney’s bottom line when it reports quarterly results on Tuesday. The upcoming “Planes,” derived from Pixar’s “Cars,” is bound to be a success, too. But a Breakingviews analysis suggests the studio’s value to the Magic Kingdom falls short of the $7.4 billion purchase price. High-priced deals for Marvel and Lucasfilm may also disappoint investors in the long term.

Sorting out Disney’s relationship with Pixar was one of the first things on Iger’s agenda when he took over in 2005 and remains a hallmark of his tenure. Their lucrative co-production and distribution deal was on the rocks after Pixar Chief Executive Steve Jobs clashed with Iger’s predecessor Michael Eisner. The successful Weinstein brothers also were expected to decamp. Disney’s own storied cartoon shop was struggling. The whole movie division was in trouble. Allowing Pixar to fall into a rival’s hands only would have further weakened the company’s position.

Buying Pixar was practically a necessity, one that brought more than just technology and a small library that included “Finding Nemo.” Jobs became Disney’s biggest shareholder and a director. Pixar’s creative force, John Lasseter, also infused Disney with a fresh spark. To acquire all that from a position of weakness, Disney paid over the odds at an estimated 45 times earnings when the deal was announced.

Disney says Pixar’s value “far exceeds” the acquisition price calculated using “net present value” across its businesses. Absent more specifics, the statement requires a certain amount of wishing upon a star. Begin in the theaters.

According to Box Office Mojo, “Toy Story 3,” “Brave” and the other films have generated some $4.5 billion in ticket receipts worldwide. Margins generally clock in at about 10 percent. Generously assume Disney makes 15 percent, and that’s $675 million of pre-tax profit over the seven years to 2012, excluding the still-developing “Monsters University.”

Consumer products are the second-biggest source of revenue. Some Pixar flicks, like critically-acclaimed “Up,” may not lend themselves well to toys and T-shirts, but others like “Cars” certainly do. Princesses, pirates and Mickey Mouse and his pals are still big sellers. Pixar films account for 12 percent of Disney’s lifetime box-office revenue, including oldies like “The Little Mermaid” and “Aladdin.” Suppose they represent the same percentage of merchandise sales. At a 25 percent margin, that would mean some $580 million of profit before tax.

DVDs are another big contributor. Using estimates by research firm The Numbers and an industry standard 50 percent profit margin, this form of home entertainment has reaped around $575 million. Finally, if income from broadcast and pay television, along with streaming video, amounts to 20 percent of total box office – a figure based loosely on estimates by analysts for other film franchises and studios – that would translate into $900 million.

Tot it all up and the average annual profit from Pixar, excluding “Monsters University,” has been about $390 million. If accurate, that’s an impressive 60 percent more than the pre-tax income Pixar generated in the year before selling itself. Subtract the 33 percent that goes to Uncle Sam, however, and put the after-tax figure on the 20 multiple of earnings at which Disney trades, and Pixar would still only be worth around $5.2 billion, or about two-thirds of what Disney paid.

That doesn’t account for any extra allure Pixar characters and rides may bring to Disney’s theme parks. It’s hard to gauge the impact, especially considering the related costs that are attached to revamping these properties. Disney last year, for example, wrapped up a $1 billion renovation of its California Adventure park with new Pixar-themed rides.

After taking all that into consideration, though, shareholders seem to be under a spell, believing Disney – and Iger – can work magic through acquisitions. Another $8 billion has been splashed out on Marvel and its superheroes – again at some 40 times earnings – and Lucasfilm’s “Star Wars” franchise. Disney nevertheless still regularly trades at a stock market valuation higher than those of its competitors. Suspension of disbelief is part of what Disney sells, but investors shouldn’t so easily fall for it.

Author Profile

Jeffrey Goldfarb writes about investment banking and the financial sector. Jeff joined from Reuters in London, where he oversaw European corporate finance coverage. Before that, he led Reuters' reportage on the European media sector, and previously wrote about M&A in New York. From 1993 to 2001, Jeff covered legal and regulatory news for BNA Inc. in Washington, DC, Phoenix and New York. He is a graduate of the Columbia University Graduate School of Journalism and the George Washington University.